Private consumption in East Asia is not too low

According to many commentators, setting the global economy on a right path these days must include a sharp increase in private consumption in East Asia. Consumption, these analysts argue, is very low across the region, and levels nearer those in advanced economies are more appropriate.

This does not seem right. Consider the following points:

Consumption in East Asia has been growing very fast. For developing East Asia as a whole, private consumption rose by almost 6 percent a year on average adjusted for inflation over the last decade, or 3 times as fast as in the U.S. (In dollar terms, not adjusted for inflation, private consumption has been growing at about 9 percent a year in China and somewhat less in the rest of the region.) Private consumption contributed almost twice as much to output growth a year in China than in the U.S. even before the crisis. Once the crisis began, private consumption in the U.S. and other advanced economies declined, while it kept rising in China and the rest of developing East Asia. And compared with 2007, private consumption in East Asia is about 25 percent larger in 2010, while it is still down 1 percent in the U.S.

“Consumption-led” growth is a myth. Output growth results from the accumulation of factors of production – capital, labor, land and others – and from technological progress. Consumption is not a factor that drives growth, it is the residual. And at early stages of development, rapid consumption growth – as we have observed in East Asia – is possible only with rapid investment growth. Cut down on investment to boost consumption and given the low level of capital in the region, output growth will plummet, and with it consumption growth.

The key argument of those that suggest consumption in East Asia is low comes from observing ratios of private consumption to GDP. Such ratios, however, are not particularly inspiring. Consumption in China is growing at 9 percent a year in dollar terms not adjusted for inflation – it just happens its GDP is growing faster, resulting in a relatively low ratio just below 40 percent of GDP.

Even if one considers such ratios for a moment, a lot of the intuition about what “normal” ratios should be comes from noting that private consumption in the U.S. amounts to about 70 percent of GDP. But such outsized levels – including for housing – drove the bubble early this century and ultimately lead to the greatest economic and financing crisis in five decades. Why should they be any guide? Consumption levels in other advanced economies much smaller than in the U.S. Witness Germany’s or Japan’s levels of consumption equivalent to about 56 percent of GDP – about the same as in Indonesia and Thailand, and certainly lower than the 70 percent in Philippines, all countries with incomes per capita at a fraction of those in advanced economies.

Last but not least, Korea, Singapore and Taiwan China had subdued consumption levels during their respective take-offs. In Korea, private consumption fell to 40-45 percent for much of the last two decades, from levels near 70 percent immediately after the devastation of the Korean war in the early 1950s.

Rapid growth requires high investment, not high consumption. And this is especially relevant for the countries of East Asia, which – including China – still have levels of capital that are much smaller on a per capita basis than in advanced economies. And this is where rebalancing can indeed occur. East Asia’s middle income countries other than China need to invest more – much more – compared with current levels. They have the resources – current account surpluses suggest these countries export savings rather than invest them at home. China also needs sustained high investment, but the pattern of that investment can be rebalanced to ensure the sustainability of growth, economically, socially and environmentally. And this rebalancing will allow the share of household income in output to rise – allowing households to increase consumption if they see fit without reducing saving. But more on this in the next post.

Not sure I entirely agree with this point, Ivailo. Consumption, investment, exports... are all endogenous variables so at some level it doesn't make any sense to say consumption or investment drives growth. Growth is driven by changes in preferences and technologies and through these the gradual augmentation of wealth relaxes the constraints under which economic agents optimize.
But even if you want to see through which of these channels growth is affected the most, isn't consumption eventually the most critical determinant? Isn't one of the key drivers of investment today the prospect of consumption tomorrow? Isn't the driver of export demand in one country the ability to consume more or differently in another country? At some level, all growth is driven by consumption.

Thanks for your comments, Philip. When people talk these days about consumption-led growth, they mean one thing and one thing only: that countries in East Asia need to consume more today to create faster growth.
What drives these recommendations, of course, is the thought that higher consumption means lower saving, thus lower current account surpluses. And the thought that more consumption today equals more growth today is trivially true - this thought describes an identity.
But consumption is not low in East Asia; it is investment that is low. Remember, fixed investment in Japan and Korea during their takeoffs was about 31% of GDP a year. Other than China and Vietnam, no other middle-income country in East Asia comes even close. Thus, instead of consuming more - relative to GDP - why not invest more? This will add to the capital stock that is so far very small and will drive faster - or if the pattern of investment in some countries is restructured - more balanced growth. Thus, investing more today countries can consume more tomorrow, bringing into the middle class larger parts of the population.

The hypothesis that consumption (or demand) leads to a long-run growth is a post Keynesian thinking, not in the mainstream economics. I agree with Ivailo's assessment that it is investment spedning that is low in East Asia. This is especially after the Asian financial crisis. If one plots I/Y ratio for a number of East Asian countries particularly South Korea, a permanent decline in the ratio can be observed.